Role of port pricing

Introduction

Port pricing plays important role in the growth and prosperity of the ports. It influences port competition, investment decisions, development strategy etc. This paper presents the current pricing system of Kandla Port Trust and its impact on the traffic, intense competition, financial gains etc.

Kandla Port Trust (KPT) is one of the 12 major ports of India under the Ministry of Shipping, Govt. of India (Location at Annexure I). Also there are 187 minor ports under the control of various State Maritime Boards. Kandla Port faces severe competition from 20 such minor ports (Gujarat Maritime Board Ports) and private ports around it on the 1600 kms coastline of Gujarat (Annexure II) whose total traffic during 2009-10 is 2.59 times of Kandla Port’s traffic and 36.73% of the total traffic handled by all the major ports of India.

The present tariff structure of Kandla Port Trust had undergone its last revision in 2005 which is taken as a base for presenting the pricing system for this paper. Accordingly the data presented is related to the year from 2002-03 to 2004-05 and projections from 2005-06 to 2007-08.

Current Pricing System

1. Kandla Port has fixed the tariff for the various services which are classified as under :

1. for the use of properties belonging to the port such as cargo handling, warehousing, storage, supply of equipments, floating crafts, dry docking and miscellaneous charges etc.
2. The fees for the services such as pilotage, berth hire, hauling, mooring and other services rendered to the vessels and
3. Port Dues on the vessels entering the port.

Based on the above, the Scale of Rates of KPT (KPT website) has been divided into 4 Chapters. Chapter I-Definitions; Chapter II- Vessel related charges; Chapter III- Cargo related charges & Chapter IV – miscellaneous charges.

2. Pricing Strategy:

“There are four usual tariff approaches for the determination of the port charges: Cost-based tariff, investment based tariff, comparative tariff, flexible and promotion tariff. Cost based and investment based tariff aim at achieving the financial objectives whereas comparative and flexible and promotional tariff are suitable for achieving the market needs” (Cariou Handout 2010 p-16).

Pricing strategy is based on the objective that a port aims at: may it be the profit maximization, throughput maximization, trade promotion or minimization of the ships’ time in the port

The Kandla Port has adopted a ‘cost plus return on capital employed’ approach while fixing the tariff to achieve the financial objective of the port. However, congestion pricing (for the priority berthing and ousting priority for berthing) and the other strategies such as comparative tariff and flexible and promotional tariff has also been adopted for certain commodities to attract the cargo. Thus the profit maximization and throughput maximizationarethe objectives of Kandla Port.

Assessing and Forecasting Port demand:

Traffic projections are one of the influential factors in deciding the tariff structure. It gives thebasis to decide whether the tariffs fixed are enough to cover the cost and the investment. Therefore, correct traffic forecasting is crucial in any port pricing system.

In KPT, traffic projections made are in line with the projections in the five year / annual plans and the current / expected growth. (Annexure III) These projections are made after taking into consideration the various factors such as trend of cargo handled during previous years, capacity increase, economic growth, traffic handled by the nearby competiting ports, market survey based on the indications given by the port users, reports of the various associations such as Agricultural Product Export Development Authority (APEDA), Timber Association, Indian Farmers Fertilizer Co-Operative Ltd. (IFFCO), Oil Coordination Committee’s report (OCC), reports from the important importers and exporters, Expert opinions, governments policies etc.

The demand is also studied on the basis of size of the vessels handled at port (Annexure IV) based on the draft restrictions and future dredging plans of the port.

Competition level

Kandla Port Trust handles almost 80 million tons of cargo and has a sprawling hinterland of 1 million square kilometers right from the state of Gujarat to the Jammu and Kashmir. (MAP of hinterland and location of other major ports is placed at Annexure V). Port faces severe competition from nearby State owned 20 minor ports and private ports which handled 205.98 millions metric tons during 2009-10. The Herfindahl Index (H) calculated comes out 1 and clearly shows the monopoly pattern of these ports. Traffic comparison of Kandla Port and 20 minor ports of Gujarat and Herfindahl Index is placed at Annexure VI. There is also an acute competition faced by KPT from the Port of Mundra, a private port which is in the vicinity and handled almost 40 million tons of cargo during 2009-2010. Port takes this severe competition into consideration while fixing the tariff structure. Tariff rates are also made concessional and promotional if ashipper commits major volumes. Thus, tariff has been fixed considering the emerging competition by the private ports in the near vicinity in terms of traffic, tariff rates and the likelihood of losing of cargo.

Comparison of tariff is important particularly so when the port compete for the same hinterland. It is observed from the comparison that all charges are abysmally low at Kandla Port Trust except the port dues, pilotage and berth hire charges which are little higher than the GMB Ports (GMB website), due to the huge expenditure of dredging cost.

Kandla Port has less competition with the major ports as each major port has distinct hinterland without muchoverlap. Herfindahl Index (H) for these ports shows pattern of equality in the market share i.e. moderate concentration of competition with the Index of 0.09868. Traffic of all other major ports of India along with Herfindahl Index is placed at Annexure VII. However, Kandla Port puts lot of efforts to attract cargo from the nearby major ports such as Mumbai Port and Jawaharlal Nehru Port by providing the competitive rates.

Cost Structure

Attempts are made in Kandla Port Trust to evaluatecost of each component of port operations. It provides the consciousness that the inefficiencies are not passed on to the users.

For the purpose of fixation of the tariff, it is necessary to know the operating cost of the port. Operating cost includes labour cost, material cost, maintenance cost, fuel cost and other expenditure such as management and administration, insurance, security. Expenses such as retirement benefits, write off of losses are also considered for the purpose of fixation of the tariff.

For this purpose, the operations of the Kandla Port are classified into five main activities such as Cargo handling, Port and dock facilities, Railway working, Estate Rental and Township. ‘Caro handling Activity’ comprise sub-activities such as cargo handling, warehousing and storage, mobile cranes etc. and ‘Port and Dock facilities Activity’ comprise sub-activities such as Cranes, berth hire, port dues, pilotage, water supply, dry docking, dredging, flotilla etc. These activities and sub-activities are again divided into various cost centres where in the cost is booked.

Based on these cost centres the ‘Direct Cost’ of each activity is booked/allocated under that sub-activity. The ‘Indirect Cost’/overheads such as Departmental overheads, management and general administration overheads(such as store keeping expenses, labour welfare and medical expenses, engineering expenses, work shop overheads, insurance etc), security expenses, social welfare expenses, fire fighting expenses et. al are also booked under different cost centres and then they are apportioned to all the sub-activities. Thus based on the Direct and Indirect Cost, Total Operating Cost has been arrived at. To this operating cost, as stated above, the cost such as retirement benefits/ex-gratia payment, writing off losses etc. (which are called Finance and Miscellaneous expenditure) is added to arrive at the Total Cost.

To the Total Cost arrived at, Return on capital employed (ROCE) calculated @ 15% is added to get the Price/Tariff of that activity. (Rate of return is calculated on the basis of CAPM).

Specimen of the Cost Statement of Cargo handling sub-activity is placed at Annexure VIII which gives an idea as how the costs are booked under different heads.

Based on all the above factors, the copy of the cost statement for the Port is placed at Annexure IX.

Capital Employed comprises Net Fixed Assets (Gross Block minus Depreciation minus Works in Progress) plus Working Capital.

Capital employed for each activity, return on capital employed (Annexure X) and cash flow statement (Annexure XI) are placed only for 2004-05. (Such calculations are done for 2002-03 and 2003-04 also).

Cost statement also shows future projections. For income projections, traffic projections and present tariff rates are considered. Wherever the rates are mentioned in the dollar terms, the effect of foreign exchange fluctuation is given. For expenditure projection, latest expenditure is adjusted to the Wholesale Price Index for All Commodities announced by the Ministry of Finance, Govt. of India and applied to the traffic projections to arrive at the expenditure projections.

Present Tariff Proposal

As revealed from the tariff order for KPT (TAMP website) the tariff proposal is as below:

“Based on the cost structure, the financial position reveals how much tariff is required to generate the % and to make the activities self sustained. However, Port finds that such recovery of return will not be possible as it demands almost 38% hike and traffic can not bear such huge hike. Hence Port decided to recover only the short recovery/deficit of 286.40 millions (Annexure IX p-17). While doing so, however, port has considered various factors such as (i) severe competition by the nearby state owned and private ports on account of better facilities such as deeper drafts, speedy cargo handling systems (impacting ship’s turn around time which was the main reasons for getting diverted the Kandla Port’s traffic) (ii) heavy capital expenditure incurred by the ports by addition of infrastructure such as quay, heavy duty cranes, godowns, road-rail network etc. since last revision and like expenditure in the coming years (iii)substantial maintenance dredging cost to the tune of Rs.400 millions p.a. (iv) increase in the operating cost by 23.68% etc. .

Over the current rates, Tariff Revision considered a hike of 15% in cargo handling & storage, pilotage, port dues and miscellaneous charges and 50% in the berth hire charges. Port has also considered cross subsidization in other the surplus activities while deciding to go for recovery of only the deficit. However, port further gives specific justification as below for the upward revision of tariff.

For port dues, port considered the huge expenditure on account of maintenance dredging. Rates of the pilotage charges of the nearby ports which were 82% higher than the Kandla Port’s rate justified 15% hike. Huge investments by developing infrastructure like berth and heavy duty cranes which benefitted the port users by reduction in turn around time of the ships & reduction in the no. of gangs justified the hike of 50% in the berth hire charges. For pilotage, port dues and berth hire the GRT slab of 10001-30000 is focused more as 56%of the vessels visiting port falls in this category. For the storage activity also likely investment in the open storage area justified 15% hike. For the cargo handling activity however, it is observed that Port instead of giving flat 15% hike to the existing rates, used the proactive pricing by increasing the rate of those commodities in which port has monopoly in handling such as food grains, scrap, timber, salt and sugar and reducing the rates of the cargo such as ores & minerals, metals, oil cakes etc. which was getting diverted.

Kandla Port expected additional revenue generation of approx. 304.30 millions p.a. after the tariff revision.”(Annexure XII)

Recommendations on as to ho w the current pricing system could be changed to increase a) attractiveness of the port; b) the profit of the port .

Emerging growth of the GMB ports during thelast decade in terms of capacity creation and speedy cargo handling has posed a severe competition to Kandla Port. Further, tariff of the State owned ports are not subject to approval of any Tariff Regulatory Authority like Major Ports and hence very flexible and attractive.

With this backdrop, thefollowing recommendations are made to increase the attractiveness as well asprofit of the port by the cost control and cost reduction measures:

1. Port should think ofworkingon the ‘normative costing’ principlewhere by standard costs and standard tariffscan be derived which could be bench-marked for pitchingthe right actual tariffs for each sub-activity and principal activity. This will give a strict control over inefficiencies and thus will help to reduce the tariff.
2. Efforts are required to be concentrated in the areas where the potential savings are likely to bemaximum.
3. Implementation of the cost effective systems will definitely help the port to overcome the redundant costs. Developing ‘satellite’ ports at new location with slimstrength of man-power and cost-effective systems can also be thought of by the port. Best solutions in terms of making a port cost-effective and attracting traffic is to develop the terminals under public-private participationmodel wherein the risks are optimally shared/distributed and costs are brought down witha right blend of public management and private management.
4. Port, by taking up various productivity measures and specifically adding infrastructure, can reduce the turn around time of the ships and get benefitted by accommodation of the large no. of vessels. This will increase traffic at the port and thus through the economies of scale the price at the port gets reduced. Of course, coefficient of elasticity of tariff on traffic is to be found out to determine to what extent the tariff is to be reduced.(Generally ports in India are in oligopoly market and coefficient of elasticity of tariff on traffic is less than one)

For cost reduction and adding infrastructure, Kandla Port has to work on the various areas such as massive mechanization through high capacity cranes, marine unloaders, transfer mobile equipments and commissioning ofspecialized terminals such as coal terminal, car terminal, container terminal etc. for speedy handling of the cargo. Increase in the capacity of the port is urgently required as the berth occupancy at the port is 89% (Ministry of Shipping, India website) which is much on the higher side impacting the turn around time of the ship which is almost 3.09 days (KPT website). Though Port has prepared dredging plan, it is required to reduce the time span so that larger vessels get accommodated within a short period. Port requires to work on procedural delays and thinking on modernizationin terms of ‘modern Gate-in & Gate-out systems’ and web-based port community systems etc., in order to reduce transaction time and cost .

5. Port can also take up the value adding services and ‘door-to-door solutions’ tobuild -up captive customer/clientele base.

Conclusion:

Pricing plays a prominent role in any organization. It is one of the determining factors to fetch the traffic at the port. As it is said that price makes and price makes, Port has to take into considerations holistic view before taking any pricing decision.